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April 14, 2017

A lot of people
are celebrating these days and patting themselves on the back. We have a parade
of investors touting their returns and claiming that 100% CAGR is for chumps.
Multi-bagger could soon be a new name for kids :)

A bull market
feels good and should be the best of times, right? How can one argue with that?

It feels great
when your stocks are going up, making you richer by the day. You feel smart, on
top of the world and in some moments can even see that retirement on the
horizon when you stop working and live on the beach < insert additional
fantasy as needed>

By my own
estimates, I have lived through around 4 major and a couple more minor bull
runs. It felt great during those periods as I felt vindicated for sticking it out during the
drops when everyone was rushing to the exits. It is only in hindsight, I have
realized that bull market are dangerous in their own way and I was lucky to
have survived the full cycle.

Let me explain

A confluence of
factors

A typical bull market
usually coincides with decent economic numbers when most companies are doing
quite well. As a result, most participants become over optimistic and bid up
the stocks of these companies. We thus have a confluence of factors – companies
performing better than usual and being valued at higher multiples of peak
earnings.

In addition to
these factors, there are several psychological factors which come into play at
this time. Let’s go over some of them

-Social
proof: At such times, you see people around you getting rich and more reckless
the person, higher the returns. It is not easy on the psyche to watch your
friends get rich , whereas you sit around doing nothing.

-Scarcity:
During bear markets, waiting helps. As the numbers are bad or getting worse,
stock price for most companies stay stagnant at best. As a result, if you like
to dig deep into a company, you have all the time in the world. No such luck
during bull market. Any company with a half decent results gets bid up. As a
result, you can either forgo an opportunity or buy the stock with lesser due
diligence

-Confirmation
bias: A bull market gives a positive signal and makes you feel that you are
doing something right. As a result, there is a tendency to ignore risks and not
look for disconfirming evidence

-Authority
bias: If you switch on a channel, every other talking head and self-proclaimed
guru on TV is painting the vision of a glorious
future where all of us would be rich. This makes you feel as the only idiot who
does not get it

In effect there
are multiple psychological and other factors, which conspire to get your guard
down and ignore
the risks

A bad hangover

I can recall
the emotional roller coaster in the previous cycle, with the only difference
that these cycles used to run over a period of 3-5 years. The years 2001-2003
(which is ancient for most investors) was a grinding and slow bear market.

It was the
exact opposite of what we see now. I can remember buying companies selling for
5 times earnings, growing at 15-20% per annum and still going down in price. If
you think these were low quality stocks, then that was not the case. I am
talking of companies like Marico and pidilite which are the darlings of the
quality school of investing now.

A new investor
like me just could not understand why the market was behaving in this fashion.

The market
started turning in 2003 and from there it took off for the next 5 years. A lot
of my personal holdings went up multiple times (no one used the term
multi-baggers as often then) and it was great to feel vindicated/ smart.

The problem
with feeling
smart was that is that you also feel invincible. The net impact of all
these emotions is that I made a few
picks, which were marginal at best.These
sub-par picks came back to bite me during the next downturn when they performed
far worse than the overall markets.

A fight against
instincts

The natural
instinct for any investor is do the opposite of what should rationally be
done.When the markets are dropping due
to poor fundamentals and bad sentiments, the tendency of most investors is to
withdraw into a shell and wait for the sky to clear up.

This is usually
the wrong action. Unless you believe that the world is going to end (in which
case, stocks should not be your worry), it makes sense to buy attractively
priced companies as markets usually have a tendency to extrapolate the recent
trends into the future.

The same
tendency is also visible during bull markets which leads investors to buy at
the wrong price. The right action at such times would be to sell or do nothing,
if the company is not overpriced. I personally think that one should go one
step beyond – use this period to clean up your portfolio. If you hold some
companies, which you are not as confident about, sell them down and increase
the cash holding. A bull market is a good time to swallow the bitter pill when the overall
portfolio is doing well.

It is never easy

I wrote this
a year back after the market dropped by 15% and this still holds true,
except the circumstances have changed to a bull market.Instead of courage to manage the fear, one
needs the same courage to manage greed and euphoria.

It requires an
equal amount of effort (or even more) to watch everyone around you make easy money,
while you stick to your principles and refuse to take part in the madness.

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Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

Posted by
Rohit Chauhan

3 comments:

We have a great PM who has got us the GST and is pursuing the black money with demonetization and IT / ED raids. India ranks better in terms of ease of doing business. In fact, the government has gone so far as defining a new mechanism for calculating the GDP. We can expect an 8+% growth rate for decades to come and "achchhe din" for the man on the (Dalal) street. Stocks always do well in the long run and no valuations are high enough when the country has such a long runway ahead. THIS TIME IT IS TRULY DIFFERENT.

Only that the more things change the more they remain the same! Whether or not all of this translates into anything meaningful has not been considered. Of course, no questioning of the valuations is acceptable because nobody would want to spoil the party! You just need to follow the online forums to realize how happy some people are and how jealous their friends are. So expect the frenzy to continue.

And then one day, there will be a tiny-winy event causing a small-time sell-off and suddenly people would like to protect their gains. And the rest would be history...

Your point is valid Rohit. The market have moved up a lot in recent months. Even I was deliberating few weeks back on whether on invest more at current levels or not. If I look at various factors, like political stability in India(at least next 7 years), Recent measures taken to reform the economics as well as politics(to certain extent) of the country, lack of similar growth opportunities in other countries etc etc... I do not find a reason to let loose my portfolio or stop looking for further buying. But I agree that it becomes difficult to find the right stocks at right valuations in these markets, specially for the value investors. So one has to step up his /her risk quotient and determine which stocks to invest in.

I would still be a buyer in the market, but without letting myself too loose on the yardsticks for stock picking. Emotions should be kept aside.

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Disclaimer

I do not provide investment advisory service via this Blog. The stocks discussed on the blog and each post are for educational and discussion purposes only and are not recommendations to buy or sell stocks.I may or may not have a position in the stocks discussed on this blog. For any investment decision, please contact a certified investment advisor.